Costing and pricing in the real world: the VAT issue, inflation and affordability

For the moment we’ve lost the battle with the Zambia Revenue Authority (ZRA) to have Kit Yamoyo zero rated for VAT purposes. The ZRA pointed out that Kit Yamoyo contains soap which is VAT-able and so VAT should be charged on the kit at 16%. We responded saying that Kit Yamoyo has been approved by the Zambia Medicines Regulatory Authority (ZAMRA) as a medicine and medicines are zero-rated for VAT purposes.

The result is an unworkable compromise. The ZRA have now agreed that we only need to charge VAT on the soap component of the kit. This would mean we’d need to add 3% VAT to the kit overall. The problem is that the accounting system at Pharmanova (the Kit Yamoyo manufacturer) can’t deal with a VAT rate of 3%: it’s 16%, 0% or exempt. The same goes for the accounting system at Shoprite. So for the moment we are stuck with having to charge 16% VAT.

This means that including soap in the kit has a massive impact on the cost of the kit to care givers. Taking the soap out would reduce the ex-factory cost of the kit by a significant 30%. Not only do you reduce the cost of the kit by the cost of the soap, but the kit then becomes zero rated. This 30% reduction would then ripple through to retail prices.

The graph below is from Friday’s (20-May-16) dashboard and shows the average retail prices (in Kwacha) at retailers visited so far this month. The number in the box at the base of each column is the number in the sample.

These retail prices are three times our target when we began the scale-up. Our target retail price when we were planning the scale-up (K5.00 – K6.00) was based on what care givers said they were willing to pay, in 2013.

It is not just this VAT issue that has pushed up prices but also the unprecedented rise in inflation in recent months. Ever since we started our work in late 2011, the inflation rate has been between 6 and 8%. That changed significantly in Oct -15 when it leapt to 20%.

What is incredible is that despite the VAT issue and inflation working against us, we are smashing through our sales targets of 1.5 to 2.5 kits per retailer per week. The graph below is also from Friday’s dashboard and shows average reported sales from retailers contacted this month.

Although these sales are very reassuring, the fact remains that many more caregivers would be able to afford the kit if it were 30% cheaper.

So, we are responding.

Next month Pharmanova will launch a new format of the kit without soap included, called Kit Yamoyo ESSENTIAL. Although the new format will be produced alongside the current kit which still contains a soap bar, we are hugely disappointed by this development. Hand-washing with soap has been proven to prevent around half of all diarrhoea cases. And the use of soap has become part of the process of using Kit Yamoyo.

It is likely that the VAT issue will be the beginning of the end for ‘Kit Yamoyo with soap’, although we do have one or two ideas which we want to try before giving up on it completely. Watch this space.

Comments

Simon, yet another great example of how you turn a problem into an opportunity.

I know the ideal is to have soap zero rated – but having two SKUs whilst adding complexity allows you to achieve your objectives of low cost mass distribution and take up, and an incentive for retailers to stock more given margin.

At least you move forward and can continue the fight to zero rate soap as a medicine whilst growing Kit Yamoyo.